Keep losses small and let profits run

by Joe Ross In the following you will find an excerpt from the book Trading is a business by Joe Ross, that can be purchased through our website http://www.tradingeducators.com. KEEPING LOSSES SMALL I cannot say this enough times, so Im saying it againyou must learn to keep your losses small. It is the single greatest concept that I can show you that will help you make profits in the market. This principle is of such magnitude that it dwarfs all other principles for trade, money, and risk management. Did you know that if you keep your losses small, you can flip a coin for go longgo short, and you will make money in the markets? Yes, without even the benefit of trade selection you will make profitable trades if you learn to control your losses. That means getting out as soon as you see that the trade is not doing what it should. I know that losing is contrary to human nature. I know how much you hate to take those losses. I know how much you detest admitting you are wrong, especially when youve put a lot of work and planning into a trade. But consider this: If the trade doesnt almost immediately go your way, then you have made a mistake! Either your planning was wrong or your timing was bad. The good trades virtually always immediately go your way. I can usually spot which of my students will become good traders. How can I tell? They are the ones who are concerned with getting out fast and not losing money. They keep tight stops. They are anxious to protect profitseven small profits. They dont give a trade room until they have locked in some profits. They are the ones who realize that most trades will result in little or no profits, but they realize that the market is going to hand them a sizable profit from time to time. Therefore, they conserve their capital waiting for the big windfall to be handed to them.

They are the ones who exert patience in waiting for such an event to happen. They know that they have to score big only a few times a year to get rich in the markets. In effect, they do not overtrade. I can tell from what you say at my seminars and what you say when you phone me, that most of you trade far too often. You think that you have to trade every day. You are so greedy to take every opportunity that comes along, that you end up making lots of bad trades. Trades must be planned ahead of time. They must meet every criteria for a good trade. They must be easily seen, and clear cut. There can be no guess work. If you flipped a coin whether to go long or short, presumably, over time, you would go long 1/2 the time and short the other 1/2 the time. My guess is that half the time you would be correct giving you 1/2 of 1/2 correct trades. It has been statistically shown that a 25% trader can make money in the markets with proper risk management. So for some of you, those unwilling to do the proper planning that results in good trade selection, you would be better off flipping a coin, taking small losses on 75% of your trades, and then milking the 25% winners for all they are worth, while making sure that your winners do not turn into losers. THINK ABOUT IT! Maybe you should break out a copy of the Life Index and spend some time working on what is wrong with YOU that causes you to lose consistently. STAYING WITH WINNERS As traders, each day we face situations that demand buy or sell decision making. If we are daytrading we may be faced with more trading decisions than position traders, but not necessarily so. It depends upon how many markets we are following. Its as though we never run out of decision making opportunities. When we decide correctly, we should make money. When we decide incorrectly, we usually lose money. If we constantly make decisions in order to satisfy some inner need, or because we get some kind of rush from decision making, then we are our own worst enemy. Trading for the attack or flight adrenaline high is almost a sure way to consistently lose. As traders, unless we are hedgers, we are speculators. It has been my experience that constant decision making does not result in success as a

trader. To be successful, we need to avoid overtrading (constant decision making) for making decisions with decreasing frequency. The more we engage in decision making, the more we expose our equity capital to chance of loss. Our chances of entering a trade correctly on the flip of a coin is small. We use trade selection and planning to increase the chances of entering a trade correctly. Still, because we may not time the trade exactly right, our chances of entering the trade correctly are small. How many times have you entered a trade, had it go against you, gotten out with a loss, and then seen it do exactly what you had planned on its doing? What was wrong? Your timing was wrong! That is why you have to get out right awaytake your hit and get out NOW! You can always get back in when you see the trade begin to go according to plan. Once in a trade, the chances of exiting it correctly are even less than they were for entering the trade correctly. The chances of being right on both entry and exit are the smallest of all. Therefore, the fewer decisions you have to make about trading, the better off you will be. This fact is the best reason I know for placement of resting stops for both entry and exit. Resting stops allow the market to come to you. Resting stops on entry allow the market to sweep you in when the market is moving your way: If it keeps on moving then you will make money. If the market doesnt keep on moving, then something is wrong and you must get out quickly. On exit, resting stops take away the need for a decision in the heat of battle, when you are most apt to make the wrong decision. How often do you get to buy at the bottom or sell at the top? Occasionally, by pure chance, it happens. Usually, you are forced to go with the trend. You must be a buyer in bull markets and a seller in bear markets. You must let the market tell you what to do. If you dont, then you have some kind of ego problem that makes you think you can control the markets. You want to be God! Now to get to the main point of this chapter, staying with winning trades, which is the same as staying with the trend. To stay with winning trades, you must drop from your thinking any and all reasons for getting out other than what the market itself is telling you. You must rid yourself of virtually all technical indicatorsall too often they will lie to you. RSI, Stochastics, %R, and others will tell you that the

market is overbought or oversold, when indeed it is not. This will cause you to get antsy and bail out too soon. Oscillators such as DEMA, MACD histogram and others will begin to drift, even change trend, while the market goes merrily on its way making profits for others. These contrivances will even show divergence long before the market makes its extreme, thereby influencing you to get out before you have a need to get out. You must quit counting waves, Elliott or others. There is no law that says because this is the fifth wave, that it is time to get out, or that there will not be another wave that will push prices even further along in your direction. Remember, the name is Elliott Wave Theory, not Elliott Wave Fact. The same is true for cycle theory. These nonsensical doodads will cause you to get out too soon, to get out before youve realized all the possible profits from the trade. The only sound basis besides simple chart reading that Ive ever found for exiting a trade is the trailing stop. Granted it keeps you from getting out at the market extreme. When you are too busy to constantly track every trade all day long, the trailing stop makes more sense than anything else. Almost any logical scheme for trailing it is good. You can draw a trend line and keep moving your stop just outside the trend line. You can curve fit a moving average to the trend and keep your stop just outside the moving average. It doesnt much matter whether the moving average is simple or exponential, or whether it is offset or not offset. You can trail your stop just beyond the extreme of the last market correction. The main idea here is that once a position is in the money, you dont give back more than 1/2, or 1/3, or 1/? of what youve already seen in unrealized paper profits, and besides protecting that 1/? of what youve seen, you DO NOT CROWD the trade. Give it room. If you are using a 3 x 3 offset moving average and it shows good containment of the trend, then at the point at which there are ample profits, you may even switch over to say a 7 x 5 offset moving average containment, to give the trade plenty of room to continue its trend. Another way to help you to stay in winning trades longer is to view corrections as opportunities not to unload your position, but rather to add to your position. A good way to do this is to consider selling out part of your position at correctionsthereby taking some profits, with the idea

that as soon as the trend is underway again, you will put on additional positions. Remember, when you add a new position you are adding new risk and you must trade add-on positions in the same way that you would trade any new position, carefully, and with tight initial stops. When you are riding a winner, avoid looking at it all the time. Search out new trades in other markets. Absorb yourself with looking for opportunities elsewhere, if you are the type that must have market action. Diversification is the key word here. But remember, you can afford to take only the very, very best trades elsewhere when you are riding a winner. Dont blow away the profits you are making on your winner by maniacal trading in other markets. The best, and perhaps the only way to make money in the markets, is to cherish and succor your winning positions. Stand back and admire them, appreciate them. Let them develop, unfold, and make you money. One final bit of wisdom and perspective before I close this section. Please dont confuse staying with winning trades with long term trading. They are not the same. In my own case, most of my long held winners start with a short term daytrade held overnight because I am trading the breakout of a major entry signal, such as a Ross hook, or a 1-2-3 high or low. For most traders, because they dont have the deep pockets, the patience, or both, to be long term traders, shorter term trading is best. It is in the shorter term that the trader with the smaller account can profit. In my own trading, I seldom am willing to risk more than a relatively small amount per contract on a daytrade, or the amount from low to high or high to low of two days back on a position trade. In any event, the absolute maximum I will risk on any trade in any market under any circumstance is 2.25 percent of my total trading capital on any one position. Heres a good way to handle your risk management: Divide your risk capital into 8 percent segments of declining equity balance. (For example, $10,000 account, risk maximum $800 total on your first trade. If you lose $500, then risk a maximum of 8% of $9500 on the next trade.) Such a strategy will allow you to successfully take more than a dozen hits in a row. The odds of such NOT happening are greatly in your favor. With mediocre trade selection or worse, such as the flip of a coin, you

should get at least one winner. If you ride that winner as Ive shown, you should come out ahead. Practice not trading as often as you have been. The brokers are rich enough, you dont need to trade to make them happy. When you have a winner, call in your stops often, keep em moving. If you have a broker who wants to charge you more for moving your stops often, get another broker. I actually had this happen to me once. The broker said that if I called in to move my stops more than once a week or so, he would have to charge me more. You can imagine what I told him. The horrible news is that hes still around, still milking the patsies and taking home megabucks on $65 round turn commissions. Theres a saying in poker that you should think about from time to time. It goes something like this: If youve been in the game for twenty minutes, and havent yet figured out who the patsy is, then its YOU! Think about that when you run your business of trading. Dont let your broker make a patsy out of you. If you dont know which segment of the traders you are fading, then you are probably the one being faded. Most of all, dont make a patsy out of yourself by overtrading. Take your time, be patient, let the markets show you what to do. Let the markets come to you, fill your positions, and then take you for the supreme joyride of making a years pay on a single trade. The ride is worth the wait.